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Carvana holders prepare for the worst with increased credit risk, losses

Carvana Co. It took only a few years to grow from a startup to the second largest company old car seller in the US.

Its demise could be even faster. The company burned through $2 billion in cash in the six months ended March 31 by one measure, and some analysts forecast it to be bankrupt by the end of 2023. car price is declining at its fastest rate in decades, reducing Carvana’s potential revenue from the cars it plans to sell. And borrowing to keep going is getting harder and harder as interest rates rise and money managers become more picky about lending to them.

Investors worried: Carvana’s stock is down 96% this year. Its bonds fell this month after the company posted larger-than-expected losses and are now trading below 50 cents per dollar – reflecting money managers’ belief that there is room for growth. high probability of default.

The company slowed its cash burn, spending about $188 million in the quarter ended September 30, based on free cash flow figures. The spokesperson said Carvana has $2.3 billion available, between cash and lines of credit, and another $2.1 billion for additional sources of liquidity. S&P Global Ratings said last week that the company has enough liquidity to last through the end of 2023, something Carvana agrees. It continued to gain market share in the third quarter, the spokesperson said.

But the auto seller’s trouble is a major turning point for a company that was once a hedge fund darling just a few years ago, with its glass vending machine-style towers an unmistakable sight. and along highways in major US cities.

Pandemic winner

Few companies have benefited from the pandemic economy as much as Tempe, Arizona-based Carvana. When the fear of Covid closes car dealer Across the country in 2020, consumers can go online to pick up a vehicle at Carvana and have it delivered to their door.

Carvana’s annual revenue skyrocketed, reaching $12 billion last year, more than three times higher than in 2019. But like many tech companies, Carvana prioritizes growth over profits. It bought out competitors and spent heavily on marketing and other selling expenses. It has generated net income in just one quarter since going public in 2017.

“The company has grown so fast and now we are seeing its ramifications,” said John Kerschner, head of US securitization products at Janus Henderson Group.

Carvana needs a steady stream of financing to run its business, as do many corporations. It has sold nearly $6 billion in corporate bonds over the past two years. It does Auto loan to car buyers and sell those loans to other companies or pool them in bonds known as asset-backed securities.

But funding is getting harder and harder. The company’s corporate bonds trade between 37 and 48 cents per dollar, making it nearly impossible for the company to borrow economically in that market.

‘Speak default’

Many investors who are dumping Carvana’s corporate bonds now fear auto sellers will borrow more, this time securing loans with hard assets including real estate or inventory. It’s not clear how much that collateral will be worth to other lenders, as the company hasn’t detailed the property in its filing.

But these types of secured financing will hurt existing bondholders, because they will stand behind new lenders if the company does go bankrupt. And current bond prices imply that is a real possibility.

“Carvana’s debt price is telling the story of default,” said Eric Rosenthal, senior director of leveraged finance at Fitch Ratings. “The secondary market debt price is one of the best indicators of what you will see happen to the company.”

Debt swap?

One way a company can reduce its debt burden is to ask bondholders to give up their unsecured debts in exchange for a smaller amount of secured debt. Such a swap would be equivalent to default by the criteria of bond-classifiers such as Fitch, which said it predicts Carvana will default next year.

The company has other assets that it can borrow. Real estate acquired from Adesa, a car auction CEO Ernie Garcia III told investors on a conference call that the company Carvana bought in May is probably worth about $1 billion. The struggles are personal for Garcia and his father, Ernie Garcia II, who have about four-fifths of voting control, with the younger of the two having dropped from the billionaire ranks along with stock plunge.

Its newest holders of bonds include Apollo Global Management, Pacific Investment Management Co. and Franklin Resources Inc. These bonds are backed by Adesa assets and always trade at a premium to the rest of the bonds. But in general, the company’s securities have recently traded at roughly the same price whether they matured early or after a decade, known as the bondage crash.

John Dixon, managing director and bond trader at Dinosaur Financial Group, a brokerage, said the collapse signaled “debt restructuring is inevitable. “The question is will it be taken out of court in court, consensus or adversary.”

Auto loan

Another way the company funds itself is by packaging car loan into bonds. But its funding costs in that market are also growing.

In August, Carvana sold asset-backed securities with an average maturity of about one year with a yield of 4.471%. This is more than five times what it paid in December, when ABS’s nearly year-long offer yielded only 0.83%.

Since September, yields on asset-backed assets have risen sharply for auto lenders — especially on bonds backed by subprime loans. Many auto borrowers are falling behind on paying their bills, making many investors more concerned about buying this debt-backed bond.

“There are a lot of cheap bonds out there. You don’t want to be a hero,” Kerschner said.

Carvana may have to find another way to sell its subprime loans. According to Jory Eisenberg, senior research analyst at CreditSights, one avenue the company has used this year is to sell the debt to Ally Financial through a deal that runs through early 2023. There is no sign yet. any indication that they will renew or renew the contract. Ally bought more than 60% of the $5 billion in loans they agreed to buy from Carvana. Ally declined to comment.

Companies like Ally are inundated with loans from banks Car dealer and other lenders when funding in the asset-backed market dries up. Jennifer Thomas, portfolio manager at Loomis Sayles & Co, said in an interview that they would likely seek better terms from the seller rather than renew the contract.

“The ability of car lenders to sell loans will dry up at some point,” says Thomas.

Losing that funding path could be a coup for Carvana, said Eisenberg of CreditSights.

“If it’s not renewed, it’s a disaster for them,” Eisenberg said.

–With support from Mary Biekert and Dayana Mustak.

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